Four Misleading Personal Finance Strategies

Common financial advice is often outdated or over-simplified. Contrary to widespread belief: some debt is good, it’s ok to prioritize other goals over set savings, you should spend money to boost your wellbeing now, and money talk need not be taboo. Making a financial plan that incorporates your personal circumstances, values, and goals can help ensure you are on the right track to financial success.

Financial advice is ubiquitous, and some widely accepted principles are so prevalent that they may not be subject to critical evaluation. How accurate are these common financial recommendations?

According to some experts, the answer is equivocal.

Popular advice tends to focus on implementing simple and seemingly easy-to-adhere-to strategies, due to individuals' limited willpower," says James Choi, PhD, Professor of Finance at the Yale School of Management. "However, much advice is oversimplified and does not take into account recent economic research or individuals' unique circumstances.

The following are four financial misconceptions that are outdated, inadequate, or entirely incorrect, as well as research-based alternatives to consider.

Misconception 1: All debt is detrimental

It is commonly advised to avoid taking on debt, whether it be from credit cards or other loans. A popular financial guide targeted towards millennials, for instance, asserts that "credit card debt is never good."

While there is some validity to this statement, it is important to note that utilizing debt in a strategic manner can yield positive results. For example, utilizing debt can help establish credit and can aid in the attainment of long-term objectives such as homeownership or retirement. Additionally, using cash as a form of payment can make spending feel more tangible and can limit overall spending by restricting the amount of money readily available. However, it is important to be mindful of high-interest debt as it can accumulate quickly and become difficult to pay off.

The best advice is to use debt in a wise and strategic manner. While some forms of debt may be considered beneficial, it is important to understand the potential risks and rewards associated with different types of debt.

Good debt, such as investments in education or a mortgage, can create value over time. For example, investing in education can increase one's earning potential in both the short and long-term, making education debt a reasonable investment. Similarly, a mortgage can provide financial benefits through increases in home equity, tax breaks, and potentially lower monthly costs compared to renting.

On the other hand, credit card debt, while it can help build your credit score, can also be detrimental if not managed properly. A high credit score is beneficial for future loan applications, but substantial debt and missed payments can negatively impact your score. It is important to have credit experience, but this does not mean you should accumulate debt. Instead, it is wise to pay off your credit card balance each month before interest accrues.

In summary, it is important to use debt wisely and understand the potential risks and rewards associated with different types of debt. Good debt can create value over time, while credit card debt should be managed and paid off regularly to maintain a strong credit score.

Furthermore, it is imperative to understand that debt can sometimes be a necessary means to sustain oneself. Situations such as job loss, unanticipated medical expenses, or poor financial decisions can lead even the most financially savvy individuals to accumulate high-interest debt. Therefore, if one finds themselves in such a predicament, it is important not to despair.

As highlighted by Choi, many young individuals take on significant debt at some point in their lives. However, the majority are able to regain financial stability over time, particularly as their income and ability to save increases with age.

Instead of allowing feelings of guilt or anxiety to consume one, it is essential to evaluate the situation and devise a plan. As stated by Todd Christensen, a Financial Counselor and author of Everyday Money for Everyday People, many individuals become so overwhelmed with their debt that they ignore collection calls and avoid addressing their finances altogether. However, by sitting down, evaluating the situation, and exploring options, the situation often proves to be less dire than initially perceived.

Myth 2: It is recommended to save a significant portion of each salary.

The traditional advice on savings suggests that one should save a fixed percentage of their income every month, regardless of their current situation or how their life changes over time. For instance, in a recent article that compared popular financial advice with economic research, it was found that 32 out of 47 popular financial advice books emphasized the importance of saving immediately, while 21 recommended keeping the savings rate - typically between 10% and 20% of total income - constant throughout one's lifetime.

There are indeed benefits to consistently saving as early as possible. Saving early and regularly capitalizes on the power of compound interest (early savings tend to grow more than later savings), and a set monthly investment may also help mitigate emotional responses to market fluctuations. Furthermore, committing to regular savings early on can also help establish it as a lifelong habit.

However, there are also circumstances where it may be more appropriate to prioritize other needs or financial goals over saving. The more practical advice, therefore, is to create a budget for spending and saving based on one's personal circumstances and goals.

Firstly, when one is younger, they may have less disposable income than when they are older. In this case, instead of adhering to a fixed rate, it would be wise to increase the savings rate as overall income increases. Additionally, from an economic standpoint, it is almost always more beneficial to pay off high-interest debts such as credit cards before saving, as most investments tend to have a lower rate of return.

Lastly, even if one wants to save every month, a flat rate of savings is not always optimal. Instead, it may be financially sound to put a larger portion of one's money towards high-interest debts or other pressing concerns, and then increase savings rates later on.

Myth 3: It is deemed irresponsible to expend on items or activities deemed as "unnecessary" or non-essential.

The conventional wisdom of cutting back on all non-essential expenses until all financial goals are met is not always the most effective approach. While it is crucial to prioritize basic needs and fulfill financial obligations, such as paying for housing, healthcare, and bills, it is also important to consider the role that money plays in our overall wellbeing and happiness.

Instead, it is recommended to create a financial plan that aligns with one's goals and includes some room for enjoyment in the present. This can include small indulgences, such as treating oneself to a cup of coffee or dining out with friends, as well as larger expenses that provide valuable experiences, such as traveling or pursuing a low-paying dream job.

It is important to remember that money is not an end in and of itself, but rather a tool to enhance our lives and achieve our goals. By balancing the need for financial security with the desire for enjoyment and experiences, we can create a more sustainable and satisfying relationship with money. Additionally, research indicates that certain types of spending, such as spending money on experiences and others, can have a positive impact on our happiness.

Ultimately, the decision of how much to spend on non-essential items will depend on one's individual circumstances and priorities. If, for example, the opportunity to live in a desirable location or pursue a dream job is deemed more valuable than saving money in the short-term, it may be reasonable to make that investment. As long as one is committed to saving more later and their income is likely to increase with age, this approach can be a viable option.

Myth 4: Discussions surrounding financial matters are considered impolite.

It is traditionally considered impolite to discuss finances in Western nations, particularly in the United States, where individuals tend to associate their sense of self-worth with financial worth. Surveys indicate that the majority of individuals in Western cultures refrain from discussing financial matters even with close friends and family, citing reasons such as it being too personal or feeling inadequate to have an informed conversation.

However, it is important to note that open and honest conversations about finances can be beneficial in terms of supporting one another and sharing information. By discussing financial matters with family, friends, and colleagues, individuals can share ideas and provide feedback on important financial decisions. Parents can impart valuable knowledge and habits to their children by involving them in financial discussions and decisions. Couples who openly discuss their financial goals tend to have healthier marriages. Even among neighbors, discussing finances can lead to improved financial behavior.

It is likely that individuals are more inclined towards discussing monetary matters than perceived. In fact, discussing financial difficulties may enhance trust and intimacy within relationships. In many critical life choices, individuals often seek guidance from others.

According to Davydenko, "consulting with others is a means of obtaining support and advice." People can benefit from seeking the opinions of others when making financial decisions, just as they would when making medical decisions or choosing between job offers.

While there is a vast amount of financial advice available, it is crucial to determine what is most suitable for one's personal situation. The commonly recommended advice by experts is to take into consideration one's short-term and long-term goals and values, and to develop a plan accordingly.